After the discussion in my post yesterday on the Investment Boost subsidy scheme announced in the Budget I thought a bit more about who was likely to benefit the most from it.

The general answer of course is the purchasers of the longest-lived assets.

Why? Because if you have an asset which IRD estimates to have a useful life of 100 years, your straight line depreciation deduction normally would be 1% per annum for each of those 100 years. But under investment boost, you get to do almost the first 21 years of deductions in the first year (the 20% Investment Boost deduction plus your 0.8% normal depreciation), and then the annual deduction each year thereafter is reduced by a little. But money today is very valuable relative to money given up (ie higher taxable income because of reduced future annual deductions) decades hence.

If on the other hand, you have an investment asset that has an estimated life of only 5 years (and there are many of them) it would normally be depreciated (straight line) at 20% per annum. Under Investment Boost, you get to deduct 36 per cent in year 1, but that additional depreciation upfront is clawed back over only the following four years. The Investment Boost additional upfront deduction has a positive present value, but it is fairly modest for such short-lived assets.

And what are the longest-lived assets? They will mostly be buildings. And, as we know, last year the government (with Labour’s support) moved to abolish tax depreciation altogether on commercial buildings (with an estimated useful life in excess of 50 years).

And that hugely magnifies the advantage of the Investment Boost policy for purchasers of new commercial buildings. Not only are they very long-lived assets but because there is no general tax depreciation on these assets, there is no depreciation clawback. The 20 per cent Investment Boost deduction is just pure gift (recall that the actual value to companies of all these deductions is 28 per cent of the value of the deduction itself – the company tax rate).

I did a little illustrative exercise in the table below, comparing the present value of the Investment Boost deduction for three different types of assets: commercial buildings, a winch (which IRD estimates has a 10 year useful life), and a printer (IRD estimates a five year useful life). Under the policy, in year 1 you get to deduct 20 per cent of the value of the asset plus normal depreciation calculated on the remaining 80 per cent. I’ve evaluated each option using a discount rate of 5 per cent (choice of discount rate won’t change the relative story across assets).

On plausible scenarios, Investment Boost is much much more beneficial to purchasers of commercial buildings than it is to most other assets (eight times as much for the same capital outlay on an asset with a life of five years[but see update at end of post]). There are, of course, other business assets with longer useful lives than 10 years (my winch example) but if you skim through the IRD schedule not that many more than 15.5 years.

And this a sector that just a year ago the government thought should get no tax depreciation at all…..

And a reminder, per yesterday’s post, that the IRD Fact Sheet on this policy says that (new or extended) rest homes will get to benefit from this (substantial) deduction, but that rental accommodation built afresh for any demographics to live in will not.

I challenge you to find the intellectual coherence in that.

Of course, you wouldn’t have got from anything announced on Budget day the sense that new commercial building purchasers were going to be by far the biggest winners. The Minister’s press release on the policy talks of how

To achieve that growth, New Zealand needs businesses to invest in productive assets – like machinery, tools, equipment, vehicles and technology.

But not a mention of commercial buildings. And perhaps more strangely, there is no discussion at all in the IRD/Treasury RIS of which sectors will benefit most, let alone the consistency with last year’s policy initiative on tax deprecation for commercial buildings, or of the rather anomalous situation where some new commercial residential accommodation (rest homes) gets the subsidy, while most of that market doesn’t. Quite extraordinary really.

It needn’t have worked out that way. Had the policy been set up to allow (say) double the normal rate of depreciation, until the asset was fully depreciated – rather than a flat 20 per cent in the first year – then there’d have been no benefit for commercial buildings at all (and whatever the merits of that at least it would have been consistent from one year to the next). Doing it in combination with restoring tax depreciation for commercial buildings might have involved initial backtracking but would at least have the merit of some consistency and coherence now.

UPDATE: A commenter notes that I really should compare scenarios with replacement at the end of the asset’s useful life. That is right. It will matter for the absolute comparison between 5 and 10 year assets (reduces the PV margin of a 10 year asset to 15% or so), and for the absolute scale of advantage of commercial buildings, but – since there is no clawback at all in respect of commercial buildings – it does not change the point that Investment Boost most strongly favours commercial building investment. Moreover, and all else equal, an investor with even a mild degree of risk aversion would favour cash in hand (20% immediate deduction on a 100 year life asset) over the uncertainty of the deduction regime at each replacement of shorter-lived assets.